Home Equity

Is It Time To Grab Your Home Equity?

If you bought a home in the past few years the odds are overwhelming that your equity increased. According to the National Association of Realtors, the value of a typical home grew by 12.6 percent last year. That means a house worth $184,100 at the end of 2004 was likely to be valued at $207,300 at the start of this year -- an increase of $23,200. No doubt a lot of owners are looking at higher home values and wondering if now is the time to get a home equity loan. For three reasons, at least, it's a question that should be asked.

First, home equity financing is typically available at rates far below the cost of credit card financing and most other forms of consumer borrowing. By getting a home equity loan and paying off old consumer debts it's likely that you can substantially reduce monthly costs.

Second, unlike consumer loans, the interest paid for up to $100,000 in home equity financing is generally tax deductible. However, the rules regarding interest write-offs are not straight-forward, there are circumstances where some or all home equity interest may not be deductible. For details, speak with a tax professional.

Third, you can often get a home equity loan without paying any fees or charges. This does not mean there are no costs, rather the lender will pay such expenses under certain conditions.

So there you have it: Home equity financing is cheap, the interest is likely to be deductible and you don't need a lot of cash -- or maybe any cash -- to sign up.

But despite all the good news regarding home equity loans, such financing is a form of debt. Just like a regular mortgage, if you don't pay you can lose your home and that's a very good reason to be careful.

What do you need to know about home equity loans? Here are the basic questions to ask:

How much can I borrow? Loan programs differ, but many mortgage lenders will provide enough home equity financing so that total mortgage debt equals 80 to 100 percent of the property's value.

If you have a home worth $550,000 and a current loan balance of $300,000, you might be able to get a home equity financing ranging from $140,000 to $250,000. In this example, 80 percent of the home's equity would be $440,000. This amount, less current debt ($300,000), means that $140,000 would be available to you with a home equity loan. At the 100 percent loan-to-value level, $250,000 would be available -- $550,000 in equity less $300,000 in existing debt.

How much should I borrow? The fact that you can borrow big sums does not mean it always makes sense to obtain the largest possible loan. When looking at potential home equity loans be certain that the payments will be comfortable, both now and in the future. Since most home equity loans are adjustable-rate products, you need to consider that rates and monthly costs can go up.

What type of home equity loan is best? There are two basic forms of home equity loan, the cash-out refinance where you receive a lump sum at closing and the home equity line of credit (HELOC). The cash-out refinance is simply a fixed- or adjustable-rate second loan on the property, while a HELOC is much like a credit card -- you draw money as needed and interest is charged on the balance. As you pay down HELOC debt, more money is available to borrow up to the original credit limit.

There is no "best" choice between a simple second loan and a HELOC. Instead, go with the option that makes the most sense given your finances and preferences.

How can I avoid the debt monster? If your reason to get a home equity loan is to pay down consumer credit, that's fine -- as long as you do not go out again and rack-up more consumer debt for credit cards, car loans and other expenses.

Combine home equity payments with a new set of hefty consumer bills and your financial position can get worse so plan ahead: Part of every home equity loan should be a plain commitment to establish a budget and avoid additional consumer debt.

Is there a catch to those home equity loans that require no cash to close? Such financing often comes with a pre-payment penalty if the loan is terminated within a given period, say two or three years. The logic here is fairly sensible: The lender had cash costs up front to close the loan and wants a reasonable period of time to recover such expenses. As a borrower you want to make sure the prepayment period is limited to just a few years, the shortest period possible.

You also want the best rates and terms, but beware of loans with low rates up front for a few months -- and then far higher rates and payments in the future. As always, shop before you settle.

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Peter G. Miller is a syndicated real estate and personal finance columnist who appears 70 newspapers.

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